The Labor Market Then and Now

By Amaral, Pedro; Jacobson, Margaret et al. | Economic Trends, December 2012 | Go to article overview

The Labor Market Then and Now


Amaral, Pedro, Jacobson, Margaret, Millington, Sara, Economic Trends


12.03.12

While the third-quarter's real GDP growth rate of 2.7 percent was an improvement over the second quarter's 1.3 percent, it may turn out to be the best in a lackluster year, as most forecasters are currently predicting that growth will slow down in the fourth quarter. The labor market has been front and center in the minds of economists as they have been evaluating growth prospects. The Federal Open Market Committee (FOMC), the Fed's monetary policymaking body, is no exception. In its most recent statement, the Committee emphasized that without substantial improvements in the labor market, the Fed will "continue its purchases of agency MBS, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability."

To get an idea of what such improvements might consist of, we compare current labor market condidons to those at the times when the FOMC started to increase the federal funds rate after the last two recessions, in the early 1990s and early 2000s. We use these points in time as a proxy for dates at which the FOMC might have thought the labor market had improved substantially. Of course, given the dual mandate, this proxy is not perfect. For example, the Committee might not have been fully satisfied with the progress in the labor market on these dates, but because inflation was picking up, it had to tighten policy. Looking back at past inflation, we feel this might have been the case in February 1994, when the FOMC first increased the federal funds rate following the 1991 recession, but it does not seem to have been the case in June 2004, when the Committee first started tightening policy following the "tech bust." With this caveat in mind, the comparison should still be informative.

The last three recoveries have been dubbed "jobless," as substantial increases in employment have lagged behind increases in GDP. This can be seen by looking at the path of the unemployment rate from the peak before each recession, through the trough of the recession (centered at zero in the chart below), and up to the first fed funds rate increase. In the current episode, the unemployment rate went from 5 percent to a peak of 10 percent and is now back down at 7.9 percent. If the goal was to get back to the pre-recession level of 5 percent, we would be roughly 40 percent of the way. This percentage is very close to where we were when the FOMC started tightening in the recovery in the 1990s and a lot better than in 2004, when the FOMC started tightening after the unemployment rate had only recovered 35 percent of its pre-recession level.

[GRAPHIC OMITTED]

Does this mean the labor market is in the same or better shape than at the time tightening started in previous recoveries? No. First and foremost the current level of the unemployment rate is simply too high for comfort. Second, proximity to the pre-recession unemployment rate is a pretty uninformative metric: it tells us nothing about what the "normal" unemployment rate was at these different times, or what was happening to the labor force, or how lengthy the unemployment spells were.

[GRAPHIC OMITTED]

To see how far the unemployment rate was from "normal" when the Fed started tightening in the previous recoveries, we look at estimates of the long-run level of natural unemployment currently estimated by Tasci and Zaman (2010) and compute the gap between it and the actual unemployment rate. …

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